Written by Vanguard Senior Financial Advisor Sharon McFadden
I’m the proud parent of a 17-year-old daughter. She works hard as a student and an athlete, and I love spending time with her. I want the best for my child, as most parents do. (I’m sure most grandparents feel the same way about their grandchildren too.)
Since “best” is a relative term, my husband and I hope we can help make her life easier by ensuring she receives a solid education. That’s not to say we want to inhibit her incentive to keep working hard—we simply want to provide her with a financial head start.
A great time to start investing
A Roth IRA may be the vehicle to give my daughter that head start. Roth IRAs are retirement accounts that offer tax-free growth and tax-free withdrawals in retirement. If your child has earned income during the year, consider helping them fund a Roth IRA by gifting them contributions.
For the 2019 tax year, you can contribute $6,000 or 100% of a child’s earned income to a Roth IRA, whichever amount is less. Since a Roth is a retirement account, withdrawal restrictions apply, and income levels may affect contribution amounts—though a teenager isn’t likely to reach these high-income thresholds.
The ultimate long-term investors
How much potential growth can you expect? Let’s say you contribute a onetime $1,000 investment in your child’s Roth IRA when they’re 17. If the child keeps that money invested for 48 years (at which point they’d be 65) at a 6% average annual return, the account would be worth $15,466.* And that money is tax-free upon withdrawal.
But what if you contribute $1,000 annually for 10 years? Your $10,000 total contribution would be worth $120,660* when the child turns 65, nearly 8 times the total amount of a $1,000 onetime contribution. Again, they won’t owe any taxes on that money when they withdraw it.
There’s an urban legend that someone once asked Albert Einstein to name the greatest invention in human history. His alleged response? “Compound interest.” Based on the calculations above and the hypothetical illustration below, I agree.
The goal is to encourage your child to keep the money invested until they retire so the power of compounding can work its magic.
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